After MF Global, Insurance Weighed to Protect Futures Customers

Long-derided as unsuitable for
sophisticated futures markets, insurance is getting a surge of
attention heading into the new year as the industry works to
patch itself up after the stunning collapse of brokerage MF
Global in 2011.

Long-derided as unsuitable for
sophisticated futures markets, insurance is getting a surge of
attention heading into the new year as the industry works to
patch itself up after the stunning collapse of brokerage MF
Global in 2011.

Three separate efforts by industry leaders, traders and an
outspoken regulator are under way to address the issue of
offering broad insurance coverage to futures customers for the
first time.

The Commodity Customer Coalition (CCC), set up in the
aftermath of MF Global's failure to help clients regain their
money, has begun circulating a proposal that calls for the
industry to create its own insurance company, tentatively named
the Commodity Insurance Corp.

Fed up with what they see as authorities' inadequate
response to MF Global's collapse, the CCC's founders - traders
James Koutoulas and John Roe - discussed the plan in a meeting
this week with the chairman of R.J. O'Brien & Associates, the
largest independent futures brokerage and clearing firm in the
United States. They said they will gauge support from hundreds
of other firms in the coming weeks.

Separately, exchange-operator CME Group Inc, the
National Futures Association (NFA), Futures Industry Association
and Institute for Financial Markets said on Friday they will
underwrite a study on the cost of insurance.

Expected to be completed in the spring, the study will
consider costs for a "number of different scenarios" of
insurance programs, NFA President Dan Roth told Reuters.

He declined to comment on the CCC proposal.

More than a year after MF Global collapsed after allegedly
misusing customer funds, some $1.6 billion in customer money is
still missing. Futures traders have no access to insurance to
cover those or future losses stemming from broker insolvency or
misappropriation.

As recently as November, the Commodity Futures Trading
Commission ignored the idea of an insurance fund when it
proposed more than 100 pages of rules it said would enhance
protections for futures traders after the failures of MF Global
and Peregrine Financial, a smaller brokerage, exposed cracks in
industry safeguards. Nowhere in the proposal was there a
suggestion that funds in futures accounts be insured.

Instead, the CFTC proposes requiring futures brokers to
explicitly tell their customers that their funds are not
protected by insurance in the event of a bankruptcy or
insolvency of the broker, or if customers funds are fraudulently
misappropriated.

Peregrine Financial failed in July after its founder
confessed to stealing more than $100 million from customers over
nearly 20 years.

SALESMEN

Under the CCC plan, an association of futures commission
merchants (FCMs), introducing brokers, commodity trading
advisors and others would own a "captive insurance company" and
sell policies with various limits to customers. Policies would
offer protection in the event the failure of an FCM results in a
shortfall in customer money.

The move is necessary because the futures industry needs to
rebuild customer confidence and cannot obtain reasonably priced
insurance coverage from established companies, said Roe, a
founder of the CCC.

"Insurers look at us as an unknown quantity," he said. "The
only way we're going to get this done is if we do this
ourselves."

The plan is a private-sector version of government-mandated
insurance for securities traders, which covers losses of up to
$500,000.

Speaking about the CCC proposal, R.J. O'Brien Chairman Gerry
Corcoran said: "I applaud their efforts, but refrain from
commenting on the plan as it was conceptual in nature and no
specifics were left with us."

R.J. O'Brien is "open-minded about an insurance program that
protects customers," he added.

Antipathy toward a bailout fund in the futures industry runs
deep. In November 1986, shaken by traders' losses after a
brokerage went bust, the industry considered and then rejected
the notion of insuring customer funds in the event of a broker
default.

Yet Doug McClelland, who operates a small commodities
brokerage in Nebraska, said insurance could help restore
confidence among his clients, some of whom lost money in the
bankruptcies of MF Global and Peregrine Financial.

"It's bad enough to lose money on a bad trade but to have
somebody take it out of your pocket, that's a bitter pill to
swallow," he said.

PUBLIC VS. PRIVATE

CFTC Commissioner Bart Chilton has urged Congress to create
a government-backed insurance fund for futures customers that
would parallel the protection already in place for stock
traders.

Created in 1970 to help restore confidence to the securities
markets, the Securities Investors Protection Corp (SIPC) has
authority to use its funds to pay back securities customers up
to $500,000 per account when brokerages fail.

Chilton told Reuters he was "certainly not opposed to a
private-sector solution" but thought a government-run program
modeled after SIPC made more sense. He expects legislation will
be introduced in early 2013.

"Why reinvent the wheel here?" Chilton said. "We have a
government system for banking and securities that works well.
The easiest thing to do is just do something similar for futures
customers."

The CCC wants to set up private-sector insurance before
Congress takes action. A goverment-run fund based on SIPC would
be a mistake because it would take too long to return money to
customers, said James Koutoulas, who founded the CCC with Roe.

"If the government goes ahead and they implement a
(half-baked) solution, then that shuts the door on us," he said.

Advanced Trading takes you on an exclusive tour of Abel Noser's New York trading floor, where the agency broker known for transaction cost analysis, is customizing algorithms for the buy side, while growing its fixed income trading and transitions business.